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A federal judge has ruled that �304 of the Sarbanes-Oxley Act — a key provision of the 2002 law that calls for disgorgement of profits and bonuses from top corporate executives in the wake of an alleged accounting scandal — does not provide a private right of action for shareholders to file a derivative suit. The decision by U.S. District Judge Stewart Dalzell in Neer v. Pelino is the first in the nation to squarely address the question of whether �304 creates an implied private right of action. In his 22-page opinion, Dalzell found that Congress clearly intended for �304 to be enforced only by the Securities and Exchange Commission and not by shareholders in private lawsuits. In Sarbanes-Oxley, Dalzell found, Congress “explicitly created a private right of action in only one place, and that is in Section 306″ — a provision that prohibits corporate officers from buying or selling securities during a pension fund “blackout period.” As a result, Dalzell applied the classic canon of statutory construction “expressio unius est exclusio alterius” (Latin for “the mention of one thing may exclude others”). “Because Congress explicitly created a private right of action in Section 306 and did not do so in Section 304, the natural inference is that Congress did not intend to create a private right of action in Section 304,” Dalzell wrote. And since the �304 claim was the only federal claim alleged in plaintiff Ronald Jeffrey Neer’s derivative suit against Stonepath Group Inc. and 14 of its current and former officers and directors, Dalzell concluded that the remaining state-law claims should be litigated in state court. Dalzell’s order dismissed the state-law claims — including breaches of fiduciary duties, abuse of control, gross mismanagement, waste of corporate assets and unjust enrichment — “without prejudice.” “Absent a federal claim under SarbOx, we believe the Delaware state courts are far better suited than we are to consider plaintiff’s remaining state law based claims. We therefore elect not to exercise our supplemental jurisdiction over them,” Dalzell wrote. The ruling is a victory for attorneys Howard D. Scher, Steven E. Bizar and Thomas P. Manning of Buchanan Ingersoll. But for Stonepath Group, the dismissal of Neer’s derivative suit is only one battle in a larger war. The company is also facing a proposed class action securities fraud suit — also pending before Dalzell — that alleges similar claims of an accounting scandal that caused the company’s stock price to plummet. In the class action, lead plaintiff Globis Capital Partners is represented by attorneys Deborah R. Gross of the Law Offices of Bernard M. Gross in Philadelphia and U. Seth Ottensoser, Timothy J. MacFall and Stephanie M. Beige of Bernstein Liebhard & Lifshitz in New York. The suit alleges that Stonepath’s executives “knew, or recklessly disregarded that Stonepath was plagued by internal control deficiencies that caused the company to consistently understate its most significant operating cost. As a result, the financial benchmarks cited by defendants as the most useful measures of the company’s performance were materially overstated.” The Buchanan Ingersoll team has also moved for dismissal of that suit, arguing the entire case “rests upon 20/20 hindsight” and fails to allege specific facts to support a claim of securities fraud. Dalzell has not yet ruled on the motion to dismiss the class action. According to court papers in the derivative suit, Stonepath is “a non-asset based third-party logistics services company” incorporated in Delaware with its headquarters in Philadelphia. Stonepath derives its income “primarily from freight forwarding, customs brokerage, and warehousing and other value-added services. As a freight forwarder, Stonepath does not own or lease any significant equipment. It generates most revenues by purchasing transportation services from direct (asset-based) carriers to transport the property of Stonepath’s customers,” according to court papers. In the derivative suit, plaintiffs attorneys Brian J. Robbins, Marc M. Umeda and Kelly M. McIntyre of Robbins Umeda & Fink in San Diego, along with Steven A. Schwartz of Chimicles & Tikellis in Haverford, Pa., allege that Stonepath issued a series of accounting restatements between August 2003 and January 2005 that effectively wiped away all of the company’s previously claimed profits. The derivative suit alleged that, in 2001, Stonepath’s top executives “focused their efforts on acquiring companies, which companies have since been revealed to have a pattern of improper accounting.” As a result of those acquisitions, the suit alleged, Stonepath has been repeatedly forced to restate its financial results. The suit alleged that the most recent restatement will negatively impact reported revenue for 2001 through 2004 by $16.3 million. “To some companies, this would account for a minor blip in their bottom line. However, for Stonepath, this estimated restatement will almost completely wipe away all prior reported earnings,” the derivative suit alleged. But in a motion to dismiss, defense lawyers argued that the derivative suit should be tossed out of court because of lack of federal jurisdiction since the only federal claim in the suit was under �304 of the Sarbanes-Oxley Act — a provision that does not allow for a private right of action. Instead, the defense team argued, a careful reading of �304 shows that Congress intended that it be enforced only by the SEC. In a response brief, the plaintiff’s team in the derivative suit argued that �304 does not expressly limit enforcement to the SEC, and that courts have “recognized a derivative plaintiff’s right to assert such a claim, while no court has ever found there is no private right of action.” But Dalzell sided with the defense and concluded that, although �304 is “silent” on the issue of whether a private cause of action exists, the plaintiff’s lawyers had failed to show that Congress nonetheless intended to create one by implication. After surveying the legal landscape, Dalzell found that “no court has ruled on whether this section creates an implied private right of action.” The plaintiff’s team argued that “at least one court has implicitly recognized a derivative cause of action under Section 304,” citing the 2004 decision from the Northern District of Georgia in In re AFC Enterprises Inc. Derivative Litigation. But Dalzell found that, in AFC, the court had not squarely addressed the issue because the judge had merely denied a motion to dismiss a diversity suit “without discussing whether shareholders who raised a Section 304 claim had a right to do so.” Only two other federal decisions touched on the issue, Dalzell found, and neither court reached the question of whether a private right of action exists. In Karpus v. Borelli, Dalzell said, a judge in the Southern District of New York approved a derivative class action settlement, but noted that plaintiff’s claims were “perilously weak,” including his assertion that he had standing to bring a claim under �304. And in In re Cree Inc. Securities Litigation, Dalzell noted, a judge in the Middle District of North Carolina granted leave to amend a complaint while “explicitly deferring the question of whether Section 304 can be enforced through a private cause of action.” Forced to tackle the question head on, Dalzell applied the U.S. Supreme Court’s 1975 decision in Cort v. Ash that established a four-part test for deciding “whether a private remedy is implicit in a statute not expressly providing one.” The plaintiff’s lawyers argued that the text of �304 includes language that strongly suggests Congress intended to grant such a right. By creating a “reimbursement benefit,” they argued, Congress intended for private plaintiffs in derivative suits on behalf of the company to enforce that right in court. But defense lawyers argued that the disgorgement provision in �304 — which calls for CEOs and CFOs to give back bonuses and profits in the wake of an accounting scandal — is not a remedy designed to protect a class, but instead is designed to punish wrongdoers. The plaintiff’s lawyers also pointed to �304′s subsection (b) which allows the SEC to exempt a CEO or CFO from disgorgement when it deems such an exemption to be “necessary and appropriate.” That language, they argued, would be unnecessary unless Congress had contemplated someone other than the SEC initiating the action. Dalzell disagreed, saying “subsection (b) can be read as giving the SEC discretion to consider factors — such as the type of misconduct or the persons involved — when deciding whether it should exempt someone from an SEC disgorgement action.” Such an exemption determination, Dalzell said, “would not require as a predicate the involvement of any private litigant.” Dalzell also noted that Congress “provided no guidance for private parties or the SEC as to what form SEC exemption determinations would take, or even whether such determinations would be mandatory.” As a result, Dalzell said, “we do not see why subsection (b) must be read to require a implied private right of action.” Since the text of �304 did not resolve the question, Dalzell found that he was forced to “examine the act as a whole to see how Congress addressed private rights of action.” Dalzell noted that two sections of the law — 303 and 804 — explicitly deny private parties a cause of action. Section 306, he noted, “specifically grants one,” and �304 “is silent on the matter.” The answer, Dalzell found, lay in the contrasts between ��304 and 306. “Both address wrongdoing of officers and both provide for the issuer’s reimbursement, yet only Section 306 expressly creates a private remedy, and one with a statute of limitations,” Dalzell wrote. “Section 306 shows that when Congress wished to provide a private damages remedy, it knew how to do so and did so expressly.” Comparing the “enforcement language” in the two sections was also revealing, Dalzell found. “Congress was at pains in Section 306(a)(2)(B) to spell out who could enforce that section and how long the enforcer had to do it. Since Section 304 is silent on both subjects, it is fair to say that implying a private right would, at least in this context, require us to rewrite Congress’ statute. This we cannot do,” Dalzell wrote.

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